Tuesday, 21 May 2013

Defence ministry comes to private firms’ aid

By
Ajai Shukla

Business Standard, 18th May 13

Private
sector companies in defence have been asking the ministry of defence (MoD) for
protection against foreign exchange risk variation (ERV), a benefit that
defence public sector undertakings (DPSUs) have always enjoyed. Accepting the
plea, MoD has approached the finance ministry to approve ERV protection for the
private sector.

Defence
Minister A K Antony told Business Standard on the sidelines of a defence
function, “We have taken up a case with the finance ministry for private-sector
defence companies to be protected from ERV. Now the ball is in the finance
ministry’s court.”

India’s
private-sector defence companies have stepped up the campaign for ERV
protection after being seriously hit by the rupee’s fall from Rs 44 a dollar in
October 2010 to below Rs 56 just a few months later. Even “indigenous” defence
systems contain many imported components and sub-systems, so any depreciation
in the rupee’s value raises production costs in India and hits profitability.

Private-sector
companies say, given that defence contracts run 5-10 years from signing to
conclusion, a significant degree of ERV volatility is almost inevitable.

In MoD
tenders, private Indian companies are expected to compete against foreign
vendors, which are not affected by ERV; and against DPSUs, which already enjoy
MoD protection. Earlier this year, industry body Ficci had sent a detailed
paper to MoD, seeking a level playing field for the private sector.

Ficci had
suggested that all bidders, including DPSUs, submit their commercial bids on a
multi-currency format, with imported components quoted in foreign exchange
(forex), and components sourced in India quoted in rupees. Since 2006, foreign
vendors and private Indian companies have been submitting multi-currency bids.
But DPSUs bid entirely in rupees, while separately indicating the forex
component of the bid.

The winner
of a contract, i.e. the L-1 (lowest-cost) vendor, is selected by reducing all
quotes to their rupee value on the day of opening of the bids. For this, the
forex component in the bids of foreign vendors and private Indian companies are
converted to Indian rupees at the selling rate of State Bank of India,
Parliament Street, New Delhi.

The Defence
Procurement Procedure of 2006 (DPP-2006) and subsequent revisions mandate that
a DPSU winning a contract would enjoy ERV protection on the forex content that
it had indicated in its bid.

DPP-2011 provided
similar ERV protection to private Indian companies, but only for global
tenders, i.e. acquisitions categorised as ‘Buy (Global)’. In acquisitions that
are confined to domestic vendors, i.e. ‘Buy (Indian)’ category, no ERV
protection is provided to anyone. But DPSUs get ERV protection in single-vendor
cases, or when they are nominated for production. According to Ficci, “it needs
to be seen how this will be interpreted in case of private companies”.

Ficci also
points out that DPSUs can gain a bidding advantage by converting their forex
component into Indian rupees at an arbitrary lower rate, thus submitting a
lower rupee bid. Ficci has requested that the exchange rate used be the one
prevailing on the day bids are opened.

MoD has
grappled for long with ERV issues. In 2003, a committee headed by Shashanka
Bhide of the National Council of Applied Economic Research (NCAER) had
recommended that MoD must invariably hedge the forex component of defence
contracts against fluctuation. That recommendation remains ignored to this day.

The Bhide
committee determined that hedging forex risk would add two per cent to the cost
of a defence contract, but not hedging was likely to cost an extra 4-5 per
cent. This loss would naturally be larger during markedly negative periods for
the rupee, like in the past three years.

DPP-2013,
which has been revealed only in outline so far, was expected to address ERV
issues, but the highlights that MoD has announced so far are silent on ERV.

If the
finance ministry accepts the MoD proposals on ERV reform, it is likely these
would be promulgated as an amendment to the soon-to-be-announced DPP-2013.

3 comments:

Rahul
said...

Since Indian private sector defence INC are only beginners, they shall ideally initially join forces with DPSUs to compete against foreign vendors because otherwise there is hardly a chance of they wining as they are yet to put their money in defence R&D and have no product list to speak of.

*****considering we are talking about some serious military hardware not just pliable civilian technology.